Shareholders and bondholders are individual persons, firms or organizations who invest their money in companies to earn income from their investment. Although the basic objective of both the investors is to maximize return from their available investment, the nature of investment they make and the nature of profit they earn on their investment is entirely different from each other.
The purpose of this article is to explain the difference between shareholder and bondholder.
Definitions and meanings:
Shareholder is an investor who buys the shares or stock of a company and becomes the owner of that company to the extent of percentage of shares he owns. He receives a share of profit in the form of dividend that the company periodically declares and distributes among all shareholders. Another way of earning profit from shares is to sell them at higher prices in the secondary market.
A shareholder can be an individual person, an organization or even a governmental institution. The two major types of shares that companies mostly issue to raise funds are ordinary shares (also known as common shares) and preference shares. Both the classes of shares come with their own distinct features that make them appealing to a variety of investors with different investment purpose and risk appetite.
Bondholder is an investor who lends money to a company by buying bonds issued by that company. His status in company is different from a shareholder. Shareholder is essentially an owner whereas bondholder is essentially a creditor of the company. The income of the bondholder consists of interest that the company periodically pays to its bondholders. The companies issue various types of bonds with different denominations and features appealing to a variety of investors. These include short-term bonds, long term bonds, secured bonds, unsecured bonds, redeemable bonds, irredeemable bonds, junk bonds and convertible bonds etc. Bondholders provide funds as creditors and therefore do not own any percentage holding in the company.
Difference between shareholder and debtholder:
The main difference between shareholder and debtholder has been explained by the following points:
1. Status of the holder:
Shareholders are the owners of the company. When an individual or organization buys shares in a company, such individual or organization acquires a certain percentage of ownership of that company. Bondholders, on the other hand, are not the owners of the company. An individual or organization who buys bonds of a company becomes a bondholder of that company. A bondholder can also be called a lender or creditor. Although, a creditor can lend company in other ways, buying bonds of a company is the fastest and easiest way to lend money to that company.
2. Income and benefits:
Shareholders get profits based on their number of shares. This profit is dispersed in the form of dividends. Every company announces their dividends based on its individual policy and therefore the percentage or amount of dividends can vary for different periods or financial years. Shareholders prefer to invest in those companies that best suit their needs for earning profit. Bondholders are not entitled to receive a share in profit, they have the status of lenders or creditors and earn income in the form of interest, usually at a fixed annual rate. This interest is paid on an agreed percentage and at predetermined intervals. These intervals usually consist of a month, quarter, six months or a year. Another economic benefit that shareholders can earn is in the form of capital appreciation of their shareholding. Bonds do not usually get traded; therefore bondholders only earn interest incomes.
3. Voting rights:
Shares carry voting rights and every shareholder can vote in meetings of a company based on their percentage of holding. Bondholders merely lend their money to the company for a specific period of time and do not carry any voting rights. However, a company can issue many types of shares with some carrying voting rights and others not carrying any. For example, the preference shareholders have many privileges over the ordinary shareholders but don’t have the voting right.
4. Preference of payment:
Bondholders are preferred over shareholders in terms of payments of liabilities. Shareholders are the owner of the company but bondholders are lenders of money and therefore they are paid their interest payments first and if any profits remain these are distributed into shareholders according to the dividend policy of company.
5. Priority of payment in bankruptcy:
In case of bankruptcy or dissolution of a company’s operations, all the net assets of company are liquidated and all the stakeholders are paid according to a specific hierarchy. In such a situation, bondholders or creditors are always prioritized in their payments. Secured loans are paid before unsecured loans. After clearing all the debts of the company shareholders are paid their investments according to respective percentages if any money is left.
6. Other risks:
Shareholders as owners of the company appoint directors to run operations of their company therefore shareholders are always exposed to the risk of agency problem which is directors may not act in the best interest of shareholders rather seek personal advantages on shareholder’s wealth. However, bondholders do not share this risk with the shareholders because their investment is a loan, not an investment in the company’s equity capital.
Shareholder versus debtholder – tabular comparison
A tabular comparison of shareholder and debtholder is given below:
|Status of the holder|
|Are the owners of the business.||Are creditors of the business with no ownership.|
|Income and benefits|
|Earn dividend income and capital appreciation of their shareholding.||Earn fix interest incomes (and sometimes a premium at the time of repayment if prior agreed).|
|Carry voting right unless specifically buy non-voting shares.||Do not carry any voting rights.|
|Preference of payments|
|Are paid dividends as declared by the board of directors.||Are paid periodical interest as mentioned in the debt agreement.|
|Priority of Payment in bankruptcy|
|Are least prioritized in case of bankruptcy.||Are always prioritized in case of bankruptcy.|
|Shareholders are exposed to agency problem.||Bondholders are not exposed to any such issues.|
Potential investors always seek for secure ways of investments. An investor wants to obtain the maximum economic benefit from his or her investment portfolio. He may buy shares or bonds according to his or her risk appetite. If an individual wants a secure investment with fixed income, bonds can result a favorable investment for them. If an individual seeks growth in their investment while facing increased risks, he may invest in shares. Such investors have a long-term investment perspective in their minds because the level of return from an investment is deemed directly proportional to the level of risk.